Compensation Scheme
Definition
A compensation scheme is a regulatory safety net that may reimburse clients if a regulated broker fails and cannot return client funds. Coverage limits, eligibility, and speed of payout vary by jurisdiction. Compensation schemes do not protect against trading losses, making it essential to understand what is and is not covered when choosing a broker.
In Plain English
In plain terms, a compensation scheme is a back-up fund designed to protect clients if a broker collapses and segregated funds are missing or insufficient. If you qualify, the scheme may repay part of your money up to a fixed limit. It does not cover losses caused by trading or market movements.
How It Works
- A broker is authorised by a regulator that operates or recognises a compensation scheme.
- The broker becomes insolvent or fails to return client funds.
- The regulator confirms that the broker cannot meet its obligations.
- Clients submit claims to the compensation scheme.
- Claims are assessed based on eligibility rules and coverage limits.
- Approved claims are paid up to the scheme’s maximum compensation cap.
- Any amount above the cap may not be recoverable.
- Timelines and outcomes vary depending on jurisdiction and case complexity.
Why This Matters for Traders
Compensation schemes address the residual risk that remains even with client fund segregation. While strong segregation reduces the likelihood of loss, it does not eliminate it entirely. For traders holding significant balances or using a broker long-term, understanding compensation coverage helps assess worst-case outcomes if the broker fails.
Common Misunderstandings
- Compensation schemes cover trading losses: they only apply to broker failure.
- All brokers offer the same level of coverage: limits vary widely.
- Compensation is automatic: clients usually must submit claims.
- Coverage applies globally: it depends on the regulator and entity.
- Compensation replaces segregation: it is a secondary safety net.
How This Affects Broker Choice
Compensation coverage is a meaningful differentiator between regulated brokers. When comparing brokers, users should consider:
• Whether a compensation scheme applies to their specific account entity.
• The maximum compensation amount.
• Eligibility criteria and exclusions.
• Historical track record of payouts.
• Interaction with client fund segregation.
From a monetisation and comparison perspective, compensation schemes help users distinguish between high-trust and higher-risk brokers, supporting comparison pages that rank brokers by regulatory protection.
Risks & Common Mistakes
• Assuming compensation guarantees full fund recovery.
• Opening accounts under offshore entities without scheme coverage.
• Holding balances far above compensation limits.
• Confusing compensation schemes with insurance products.
• Ignoring which legal entity provides coverage.
Risk note: compensation schemes provide limited protection and may only cover part of a balance. They do not prevent loss and should not replace prudent broker selection.
Real-World Example
A broker fails and cannot return £120,000 of client funds.
• The applicable compensation scheme covers up to £85,000.
• The client receives £85,000 and loses access to the remaining £35,000.
The outcome reflects the scheme’s coverage cap rather than trading performance.
What to Check Before Trading
- Does a compensation scheme apply to your account entity?
- What is the maximum compensation limit?
- Are there eligibility restrictions?
- How long do claims typically take?
- How does compensation interact with fund segregation?
- Is coverage clearly disclosed in broker terms?
- Is the regulator known for enforcing payouts?
Related Concepts
Segregation reduces reliance on compensation schemes.
Regulators define whether compensation schemes apply.
Compensation schemes activate when a broker fails.
Both are protections but address different risks.
Brokers must explain compensation limits and exclusions.
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Risk Warning: This website does not provide financial, investment, or trading advice. All information is for educational purposes only. Trading and investing involve substantial risk of loss. You should carefully consider your financial situation and consult with qualified professionals before making any financial decisions.